Be cautious with investment in mid, small cap space

November 20, 2012 08:39 IST

Renu Pothen, head of research at Fundsupermart.com says she's been recommending Mid and small-cap mutual fund scheme since last year. Reason: These stocks are trading at a discount to their high prices in 2008.

Due to an improvement in the market sentiment after the recent reform announcement by the government. This upbeat mood has particularly helped stocks in the smaller market capitalisation categories.

Even the returns given by these funds support Pothen's recommendations. As per mutual fund rating agency Value Research, in the last one year, mid and small-cap funds have returned nearly 20.50 per cent. In the same period, the Bombay Stock Exchange's 30-stock sensitive index or Sensex returned only 9 per cent and National Stock Exchange's 50-stock index Nifty returned close to 11 per cent. The equity diversified funds (investing in large and mid-cap stocks) returned 13.50 per cent. (Returns as on November 16, 2012)

Pothen says those with high risk-taking ability can invest 30 per cent of their equity portfolio into these funds. But, even if you aren't that aggressive 5 per cent of your equity portfolio can be put into these funds. And if you don't have any exposure to the mid and small-cap sectors, you could take some exposure to it as looking at the current levels, most experts are quite confident about equity markets' long-term prospects.

The advantage with mid and small cap firms is their size. Smaller operations gives sufficient room for expansion to these companies. Such companies can grow at a faster pace than the established ones. And if you put money in smaller companies you can be a part of its growth phase and hence pocket good gains. In developing economies like India, growth potential of smaller companies is very high.

Also mid and small cap are high beta stocks and tend to rise sharply when the broader markets doing well and can outperform the larger stocks by a big margin. On the flip side, these stocks have a bigger downslide than larger stocks in a bear market.

However, Akshay Gupta, CEO of Peerless Mutual Fund isn't sure if a retail investor can consider mid and small cap funds in this market. "There are too many socio-political issues both on the domestic and international front. And the economy is also not functioning in the right way and large cap companies have not done well, incremantally it may not be the right time for mid and small cap investment. Mid and small cap stocks are yet to gain momentum," he says.

Gupta says even the quarterly earnings will show that large caps have done better than the smaller companies. Liquidity is another issue with mid and small caps because of which institutional investors are not convinced about these stocks.

"These stocks may have shown temporary performance due to some activity in individual companies, otherwise do not think mid and small cap right now. Lower valuations have led to a jump in returns. Largely consumption stocks in these segments have shown growth," says Gupta.

Caution needs to be exercised while investing in a mid-cap fund. Given your risk profile, you could opt for a mid-cap fund with excess exposure to large caps or go for a scheme with a higher risk-taking ability. The scheme should be suitably diversified, both in terms of sectors and stocks. A well-diversified scheme reduces risks. Any mid-cap scheme with less than 20 stocks is betting on few sectors and, hence, is riskier in nature.

Look at a fund with low corpus because it makes the scheme more nimble. So it can enter and exit stocks at short notice. Investing in mid-cap stocks is a lot more difficult. But, for those willing to take the plunge, start by looking at borrowings of the company. "If the company has raised money from the stock market too many times, it can be avoided.